Analyst Insight: With the U.S. Securities and Exchange Commission proposing new ESG guidelines, businesses can’t afford to wait when it comes to building the capabilities needed to collect and report relevant ESG data, particularly on emissions.
A company’s supply chain represents up to two-thirds of its ESG footprint, so procurement teams should focus on data visibility and flexibility in their supplier management processes, to prepare for coming regulations.
In 2022, the SEC proposed a set of climate disclosure standards that would require companies based in, or doing business in, the U.S. to disclose their ESG efforts and their climate impact. If passed, these standards would represent a significant change in the way companies go about their ESG initiatives (and how they report on them), but it’s not without precedent. The SEC’s proposal in part mirrors the European Union’s Corporate Sustainability Reporting Directive (CSRD), which went into effect in January of this year.
It might take some time for that SEC proposal to be passed, as it’s experiencing some opposition and a few roadblocks. Even though taking action against climate change is widely popular among Americans, some detractors have taken aim at ESG regulations and attempted to paint them as solely political tools. Additionally, a Supreme Court ruling later in 2022 dampened the EPA’s power to regulate carbon emissions created by power plants, suggesting that there might be a rocky path ahead for SEC’s proposal if federal agencies have less power to enforce climate regulations.
Still, based on broad support for action, the writing is on the wall: In some form, ESG regulations are coming, likely sooner than later. U.S. businesses will need to adapt and build out the capability to track, analyze and report ESG measures, including emissions. And since the CSRD applies to U.S. companies that have significant operations in Europe, those same capabilities will be needed for businesses looking to expand across the Atlantic. This will likely also be the case for other ESG regulations that we expect to see passed in other countries across the world. For companies looking to do business globally in the future, ignoring ESG regulations won’t be an option.
Making this requirement even more complicated is that the SEC’s proposal, like the CSRD in Europe, requires emissions to be reported for three different categories (referred to as “scopes”). Scope 1 includes direct emissions, like the ones created by company-owned vehicle operations. Scope 2 refers to indirect emissions created during the production of energy to be used by the company. Both of these scopes are relatively easy to track and report, since the activity is all located close to the organization or under its control.
Scope 3 is where it gets tricky, because it accounts for all indirect emissions — notably, those created by partners and outside providers in a company’s supply chain. Not only is that the hardest emissions category to track, it’s also often the largest; according to McKinsey, which states that “two-thirds of the average company’s environment, social, and governance footprint lies with suppliers.”
In the face of this daunting challenge, how can companies prepare to collect, analyze and report on the emissions of their supply chain? Procurement teams will be the ones to head up this charge, given their proximity and direct access to suppliers. Following are four tips for companies to prepare themselves for ESG disclosure regulations.
Create visibility into data. Gaining visibility into the ESG commitments and risks attributed to suppliers is vital. Visibility into their emissions output and sustainability efforts allows companies to take the correct course of action if they aren’t meeting benchmarks for suppliers, and to gather the info needed for reporting. The most effective means of getting suppliers to routinely provide that information is to build requirements for reporting into contracts and the onboarding process in third-party workflow tools. If a current supplier that isn’t reporting ESG data, use those workflow and supplier management tools to guide it through what’s required.
Pay attention to country- and industry-specific regulations. Regardless of where a company is based, it needs to follow applicable laws in the countries and regions where it operates. The burden is on the company to track at what point ESG regulations apply, and to know what needs to be done to meet those regulations. It’s also important to make sure it’s paying attention to regulations in place now and those proposed for the future. It takes time to build out collecting and reporting capabilities, so waiting around and not taking action could turn out to be costly. There could also be industry- and geography-specific ESG requirements about which companies need to remain vigilant.
Assess the risk of suppliers. Think of ESG-related supplier risk as any other risk category and treat it as such. The first step is to get visibility into current suppliers’ ESG programs and risks, and see which suppliers are likely to be a greater risk due to either poor ESG performance or the inability to report relevant data. Businesses have options for addressing these risks, and they’ll change depending on the situation and the company’s individual risk appetite. Nevertheless, they generally fall into the categories of either replacing a supplier with a less risky one, or helping that supplier get in line with ESG regulations. Prioritize the riskiest suppliers first, address them, and move on to the next.
Develop a reporting framework. ESG reporting needs to happen in specific and timely ways, and businesses should develop a framework for how the relevant data is parsed and recorded when it arrives, so that it meets the regulatory body’s disclosure requirements by the time it is finalized. That framework should include all data points that must be accounted for in the disclosure; the timeline for gathering, analyzing and reporting, and the methods of capturing the data.
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